A Lodging Conundrum

Last week I wrote about the stellar performance of grocery stores in the column "A Refresher on Defensive Investing." I have written positively about the sector in the past few years. When I originally wrote about defensive investing in 2011, I included the economy and mid-tier lodging sectors, along with grocery stores, as an area that traditionally performs well during periods of economic weakness. Last November I wrote about the lodging sector and advised, because of its stellar performance as well, that it was no longer a defensive position. Let's review what's transpired for that segment in the past three quarters and consider what is possible for the near future.

The original two companies from the 2011 column were Choice Hotels International (CHH) for the economy sector, and Intercontinental Hotels Group (IHG) for the mid-tier. Their performances have been very different in the past three quarters. Since the beginning of last November, the share price of CHH has only increased by $1, to $47.19, about 2.2% higher.

Shares of IHG have performed much better, however, increasing almost 43%, to $41.62 from $29.17. The vast majority of that increase has come in just the past two months, though, as the company announced plans to pay a special dividend on July 14, 2014, to owners of record as of close of business June 30, 2014. It was funded by the sale of two large properties in San Francisco and New York. It is also has a $500 million share buyback program that has reduced the outstanding shares by 2% since last August, thereby, supporting the stock price.

The company is generally selling its higher-end prime properties and reinvesting in the mid-tier space with new Holiday Inn and Holiday Inn Express locations, along with returning money to shareholders by way of special dividends and share buybacks. The current price reflects traders buying in for the special dividend, as well as investors looking for future growth and capital returns. I don't know what the mix of these two is, but a decline in the price back to where it was before the special dividend was announced is probable over the near term.

There is a more disturbing trend evident when we consider the performance of these two compared to the lodging brands that cater to business travelers and high-end consumers. Usually during recessions and periods of economic malaise, the companies with lower-priced lodging outperform the higher-end brands. Since the 2008 financial crisis, though, and the failure of aggregate economic activity to increase since, the higher-end lodging companies have greatly outperformed the economy and mid-tier companies.

Since last November, the stock price of Marriott International (MAR) is up 40%, Wyndham Worldwide (WYN) is up 13%, Starwood Hotels (HOT) is up 10% and Hyatt Hotels (H) is up 25%. Some of this positive performance is being driven by share repurchases, with Marriott and Wyndham buying about 2.3% of their outstanding shares just since last November. Hyatt has repurchased about 1% and Starwood is about the same.

The stock prices of all four are at record highs now. Marriott and Starwood exceeded their pre-2008 financial crisis highs in the fourth quarter of last year and continue to rise. Wyndham exceeded its pre-crisis high in January of 2012 and has almost doubled again since. Hyatt is also trading at record highs but did not become a public company until November 2009.

Choice Hotels, on the other hand, is still trading below its pre-crisis high, which was set almost a year before the rest, in June 2006. The outstanding shares are about the same today as they were last November. Intercontinental only exceeded its pre-crisis record when the company announced the special dividend in May. Its performance as a mid-tier lodging supplier has outperformed Choice and the economy sector.

The diverging trends in the performances of high-end lodging on one end and economy and mid-tier on the other is the opposite of what occurred in previous recession or economic stagnation periods. It appears to be indicative of the growing trend of income inequality as the monetary stimulus is recirculated between the Fed, banks and the largest companies with the easiest access to it, and, by extension, their employees and shareholders.

I don't know if this will change, but economic stagnation is apparently no longer a driver of revenue, earnings and stock prices for the economy segment of lodging.

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